It's May. Now what?

It's now May. The straight-line drop in risky assets that opened the year seems like a long time ago, at least if you look at most market prices. That being said, it seems quite clear that the episode remains fresh in the memories of policy-makers- or at least the ostensible catalyst for the risk-asset downdraft.

Nevertheless, equities may finally being showing some signs of rolling over. While it's true that nearly three-quarters of SPX companies have beaten EPS estimates, it's also the case that those earnings have declined more than 7% y/y. With stocks still much closer to the highs of the range than the lows, Macro Man will let readers conclude for themselves which of these factors is most in the price.

Will the onset of May herald a continuation of the nascent weakness observed last week, or is "sell in May and go away" just a trite cliche at this point? Only time will tell for certain, of course, but we can still assess the balance of probability using whatever facts we deem appropriate. Insofar as the "sell in May" aphorism is really just a comment on seasonality, Macro Man thought that it might be useful to revisit monthly returns for the SPX across a broad range of time frames. Here are monthly returns for the SPX since 2009 (the QE era):

As you can see, there are some pretty chunky average returns there....but May and June are both negative, which would argue for caution. What if we extend back to 2000?

Well, on average May is positive (barely), but does indeed usher in a period of lousy performance extending through the summer. Again, not exactly a ringing endorsement for buying (or holding) spec longs here. Going back to the start of the long secular bull market in 1982:

In this case, the average return for May is actually slightly above average, but again the returns for June through September are lousy. Going back to 1950, which is an arbitrarily chosen date that roughly coincides with the official beginning of the S&P 500:

Again, May's return is slightly positive on a nominal basis but ushers in a summer of generally poor performance. Finally, the data since 1928, the beginning of the dataset:

Interestingly, the June-August period now looks OK, while May is back negative on average. How much you want to distill from the monthly returns during the Depression and the war is up to you...but what Macro Man can say is that May has delivered below-average returns for four of these five time windows, and May-September has done so for each of them.

Given that this is an election year and that the campaign is already incredibly depressing (both of the front runners have approval ratings well below 50%), it may be useful to observe the seasonals for election years as well. As a reminder, election years have generally performed in line with the non-election years; since 1928, the monthly average return for the former is 0.46% and for the latter, 0.45%. Still, what's interesting for the purposes of May 2nd is the monthly breakdown:

May is by far the worst performing month...though in contrast to non-election years, June though August perform very well indeed. Now, perhaps you might want to argue that the sample size behind this chart is too small to draw any substantive inferences from the average monthly returns. And you'd probably be right.

But still, in the context of negative seasonality with a much larger sample, lousy earnings, waning momentum, and prices still close to their highs....let's just say that Macro Man isn't covering his (slightly offside) tactical short just yet.

Switching gears back to the dollar, the potential Portuguese downgrade did not materialize in the end, with DBRS deciding that the country remains investment-grade (again, judge for yourselves what they says about the utility of bond ratings). Nevertheless, the decision has removed one potential headwind from further gains in EUR/USD. Although Macro Man didn't comment on it last Friday, the release of Q1 GDP in the Eurozone was really quite stunning, with the region registering its second highest quarterly growth rate of the last five years. More interestingly, European growth bested that of the US for just the fifth time this decade.

Taking a step back, it's not hard to ague that recent dollar weakness is justified (or, perhaps to put it another way, that prior dollar strength may have been a little overcooked.) It's interesting to note, for example, that the 10 year FX forward points have essentially gone nowhere for the last three years (albeit with plenty of swings and roundabouts) even as USD/JPY raced from 100 to 125.....and now, perhaps, back to 100.

Similarly, long dated EUR/USD forwards haven't really moved that much over the last couple of years; in fact, they hit their most dollar-advantageous levels more than 18 months ago. To be sure, EUR/USD hasn't always moved one-for-one with long-dated forwards..though if anything, the former has led the euro. Either way, it's hard to avoid the conclusion that on some measures at least, the dollar's interest rate advantage hasn't really grown despite the imposition of NIRP and ECB QE2.

Again, none of this necessarily means that the dollar must weaken from here....but it does suggest that on current pricing, the interest rate case for a rebound is less than compelling. And that leaves the FX determination to positioning and narrative. You'd have to think that longer-term longs are getting a bit antsy about the dollar given its shoddy performance; hell, even the GPIF is talking about hedging! Meanwhile, the narrative is in the Fed's court. But with Kaplan already citing the Brexit vote as an excuse to sit on their hands, it's very hard to see the Fed driving the narrative to a more dollar positive tone barring a stunning recovery in the data.

Perhaps "sell in May" doesn't just apply to the stock market these days?

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Interesting thoughts on May seasonal, I need to take a look and see how it looks on other markets as well. Apparently its more pronounced in MSCI Asia Ex JP.

Thanks anons for the China commodity thoughts. It is quite an interesting story and aligns closely with my watching of EM FX / Commodity currencies more so than JPY/EUR (ok GBP you are a real risk).. Cad has just been a one way monster with over 20 big figures from Jan top. Thats more than just a pullback, imo. And GDX ... wow.

What now you ask..well I've put the cue in the rack a while ago in this market. Time to enjoy the British music scene and the Ascot fillies parade till the next set up comes along...many thanks to the chairman.

At the risk of upsetting MM, and sprouting 'the fed has magic beans' tosh, I have a narrative idea that goes like this: the Fed in their wisdom have noted (after perusing the internet and in excellent blogs such as this one), that the recent pop in commodities is built on the crazy Chinese moneyball (number eight for me!). So they have decided to look beyond any minor blip in PCE/CPI whatever your inflation measure of choice and are preparing to assume a position in the event this goes awry, particularly when they read that Chinese tier 1 property is up an annualized 60% in Q1 (yikes!).

Arguably, this is the correct stance, but diabolically this also results in short term dollar weakness and reinforces the Chinese moneyball in commodity futures. Oh well they don't really care about the Chinese anyway.

We may well have seen the highpoint for equities for a few quarters so hold onto that short! At this point in time, it may be an idea to look at nice entry points for a short positions in commodities, where I am guessing the highpoint may be reached in the next 2 weeks when the dollar hits a bottom.

The question then turns to which commodity has the most downside potential ? Oil, iron ore, gold, silver ?

The April PMI data suggest there’s no end in sight to the current downturn in manufacturing activity. The survey indicates that factory output is dropping at an annualized rate of approximately 3%, and factory headcounts are being culled at a rate of around 10,000 per month. (…)

Rather than reviving after a disappointingly weak first quarter, the data flow therefore appears to be worsening in the second quarter, raising question marks over whether GDP growth will improve on the near-stalling seen in the first three months of the year.

Nothing can stop stocks from marching higher. The Dow surged more than 100, NASDAQS more than 40. Lads and lasses alike, rejoice in the splendour of American capitalism, a brand of winship that is unparalleled throughout all hemispheres on Earth.

It's starting to feel like i'm the only luck SOB whose made any money on the commodity rally. Everyone hates it and still hates it. Ex-PM's, because thats just an asset class that makes no sense to me, I think theres still room to go. Consider that if nothing else almost all the equities were/are trading as fixed-duration calls on solvency - if nothing else the time premium component of them being re-rated as going concerns has a lot to do with the current eye-popping rally.

This comment chain from January of this year (when blind squirrel buying some of the doomed upstream losers - WPX in this case) has a good example of how the world has turned. The makes a good argument anon @ 1142PM basically spells out the bear thesis on a huge chunk of E&P, is short the bonds and stock, and seems to have already spent the gains. Whats happened to that trade now? Is she still fighting the good fight down 100%? How much of the bear case of solvency and inability to roll debts has simply vanished with a more open credit market and some successful secondaries? The short interests, in aggregate, are down but not much. The price decks from the sell side are way below market prices, and *still* the commodities rally. Soybeans anyone? Even absolute price agnostic players like soycrush guys (BG etc) are not rallying as much as their commodity markets suggest they "should".

I think the street is way off position here. The whole thing made much more sense when the companies were hemmoraging cash and the credit markets were closed.

I think the fed looks at core CPI when its convenient and fits the narrative they are looking for to justify policy choices. When they want to raise, which I think they do, they will find the rise in food & energy prices alarming.

Traders love to talk about the maximum pain trade. You know what I see causing the most pain? The absolute gut wrenching, teeth gnashing, just get me out pain? It's a scenario where headline/general/real inflation starts rising at a nice pace, rates get a chance to normalize, and central bankers get to take a victory lap for solving the disinflation problem. Can you imagine the pain and anguish that would cause?

"Traders love to talk about the maximum pain trade. You know what I see causing the most pain? The absolute gut wrenching, teeth gnashing, just get me out pain? It's a scenario where headline/general/real inflation starts rising at a nice pace, rates get a chance to normalize, and central bankers get to take a victory lap for solving the disinflation problem. "

T - 'get me out' of what, exactly? I think being long the 10 yr is a dodo trade in the medium to long term, so if thats what you mean you are correct - but if headline inflation begins to rise quickly (a belief that I share), be very very careful in assuming that the commodity rally would continue just from a hedging flow demand - remember crude can be 30-50 for 2 years and merely stop contributing to deflation for your scenario to come true if the wage and rent part moves, and it will.

As for the victory lap etc, they will get inflation, just don't realize what that REALLY means for risky assets - I think productivity is way too low and still dropping for us to go from deflation to goldilocks - I think the pendulum will instead keep swinging from deflation fears to inflation fears so quickly that people's head will spin - I am told this used to happen in the 70's, but I'm not old enough to have lived through that!

I am not sure about the shale stocks, but Chinese commodity bubbles surely will burst first. And then with some lag, WTI and shale stocks may follow the lead. It seems to me that this is always how it happens.

And looking at Shibor trends, the pop of the Chinese commodity future market bubble may be closer than you think assuming no PBOC action before the pop.

T - 'get me out' of what, exactly? - The bearish hypothesis that we are stuck in a deflationary vortex and growth hopes are soon to be replaced with solvency fears.

but Chinese commodity bubbles surely will burst first - I think the bubble here was in the proliferation and success of very poorly run aggressively financed chinese firms. Thats in the process of imploding, and it's unequivocally a good thing for the survivors. I don't see the aggregate demand picture changing all that much.

I don't quite understand how you MM can say that the previous USD strength was overcooked in comparison to the Euro given a consistent GDP growth rate beat? What am i missing?

I am in Leftback's camp - see some trouble ahead for the short US$ group. Fundamentally, none of the commodities should be screaming (apart from oil due to supply coming off albeit slowly). Iron Ore, Copper are still woefully oversupplied.